The fundamental backdrop, in the shape of economic lead indicators and earnings momentum, has been deteriorating: manufacturing PMIs for the US, China, Japan, Korea, the Euro zone, and the UK are all now sub-50, and consensus earnings growth estimates for 2012 have been halved in recent months. What has this meant for Global Equities? Well, as UBS notes, in the last three months, very little. The MSCI AC World index is up more than 12% from the 4 June low. That markets have rallied while fundamentals have deteriorated in this manner is unusual. Historically, equity market rebounds have tended to coincide with a trough in PMIs and earnings momentum – that is, when PMIs have stopped going down and the pace of earnings downgrades slows (waiting for PMIs to recover to 50 or for earnings momentum to turn positive is usually too late). Markets now appear to be taking their cues from central bankers: potential policy actions are becoming a sort of ‘lead indicator of the lead indicators’, if you will. Given the recent rally, in addition to underlying macro weakness, policy action - and effective action at that – has become increasingly important for investors. Without it this recent rally could end up looking more like a false start than a head start.
UBS: PMIs and Global Equities…
We have taken a long-run series of selected manufacturing PMIs from around the world (US, Euro zone, China, Japan and Korea). The vast bulk of the early history comes from the US, with some countries’ data not starting until the 1990s or even later. We have simply weighted by current GDP weights – this will only give us an estimate, but our composite measure does seem to move closely with the US ISM over the last decades.
We have circled the nine periods that we think were major turning points in the indicator since 1973 (trying to reduce some of the noise in mid-cycle volatility).
Historically, the trough in Global Equities performance has tended to coincide with the trough in the PMIs (chart 2).
But this time round the rally has occurred ahead of the turn (chart 3).
And earnings momentum has been sharply negative (and worsening) over the last three months as markets rallied. June, July, and August all saw deteriorating momentum (Chart 6),
the result of which has been a near-halving of 2012 consensus earnings growth estimates (Chart 7).
Of course, if policymakers do follow through with drastic actions that reduce Euro zone break-up risk or drive an acceleration in US or Chinese economic growth, then PMI and earnings stabilisation will follow. If this is the case then equity markets will have gotten a nice head start in the last few months. However, given the recent rally, in addition to underlying macro weakness, policy action - and effective action at that – has become increasingly important for investors. Without it this recent rally could end up looking more like a false start than a head start.